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Mutual Fund PDF
Mutual Fund PDF
MUTUAL FUNDS
1.1 Introduction
There are many investment avenues available in the financial market for
an investor. Investors can invest in bank deposits, corporate debentures
and bonds, post office saving schemes etc. where, there is low risk
together with low return. They may invest in stock of companies where
the risk is high and sometimes the returns are also proportionately high.
For retail investors, who do not have the time and expertise to analyze
and invest in stock, Mutual Funds is a viable investment alternative.
This is because Mutual Funds provide the benefit of cheap access to
expensive stocks.
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1.2 Concept of Mutual Fund
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1.2.1 Operational flow of Mutual Fund
Trustees
AMC Distributors
Entities
involved in
Mutual
Sponsors Funds Registrars
Investors Custodian/
Depositors
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1.3.1 Investors
Every investor, given his/her financial position and personal disposition,
has a certain inclination to take risk. The hypothesis is that by taking an
incremental risk, it would be possible for the investor to earn an
incremental return.
Mutual fund is a solution for investors who lack the time, the inclination
or the skills to actively manage their investment risk in individual
securities. They delegate this role to the mutual fund, while retaining the
right and the obligation to monitor their investments in the scheme.
In the absence of a mutual fund option, the money of such “passive”
investors would lie either in bank deposits or other ‘safe’ investment
options, thus depriving them of the possibility of earning a better return.
Investing through a mutual fund would make economic sense for an
investor if his/her investment, over medium to long term, fetches a
return that is higher than what would otherwise have earned by investing
directly.
1.3.2 Sponsors
Sponsor is the company, which sets up the Mutual Fund as per the
provisions laid down by the Securities and Exchange Board of India
(SEBI). SEBI mainly fixes the criteria of sponsors based on sufficient
experience, net worth, and past track record.
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An AMC has to employ people and bear all the establishment costs that
are related to its activity, such as for the premises, furniture, computers
and other assets, etc. So long as the income through management fees
covers its expenses, an AMC is economically viable. SEBI has issued
the following guidelines for the formation of AMCs:
a) An AMC should be headed by an independent non-interested and non-
executive chairman.
b) The managing director and other executive staff should be full-time
employees of AMC.
c) Fifty per cent of the board of trustees of AMC should be outside
directors who are not in any way connected with the bank.
d) The board of directors shall not be entitled to any remuneration other
than the sitting fees.
e) The AMCs will not be permitted to conduct other activities such as
merchant banking or issue management.
1.3.4 Trustees
Trustees are an important link in the working of any mutual fund. They
are responsible for ensuring that investors’ interests in a scheme are
taken care of properly. They do this by a constant monitoring of the
operations of the various schemes. In return for their services, they are
paid trustee fees, which are normally charged to the scheme.
1.3.5 Distributors
Distributors earn a commission for bringing investors into the schemes
of a mutual fund. This commission is an expense for the scheme.
Depending on the financial and physical resources at their disposal, the
distributors could be:
a) Tier 1 distributors who have their own or franchised network reaching
out to investors all across the country; or
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b) Tier 2 distributors who are generally regional players with some reach
within their region; or
c) Tier 3 distributors who are small and marginal players with limited
reach.
The distributors earn a commission from the AMC.
1.3.6 Registrars
An investor’s holding in mutual fund schemes is typically tracked by the
schemes’ Registrar and Transfer Agent (R & T). Some AMCs prefer to
handle this role on their own instead of appointing R & T. The Registrar
or the AMC as the case may be maintains an account of the investors’
investments and disinvestments from the schemes. Requests to invest
more money into a scheme or to redeem money against existing
investments in a scheme are processed by the R & T.
1.3.7 Custodian/Depository
The custodian maintains custody of the securities in which the scheme
invests. This ensures an ongoing independent record of the investments
of the scheme. The custodian also follows up on various corporate
actions, such as rights, bonus and dividends declared by investee
companies. At present, when the securities are being dematerialized, the
role of the depository for such independent record of investments is
growing. No custodian in which the sponsor or its associates hold 50
percent or more of the voting rights of the share capital of the custodian
or where 50 per cent or more of the directors of the custodian represent
the interest of the sponsor or its associates shall act as custodian for a
mutual fund constituted by the same sponsor or any of its associates or
subsidiary company.
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1.4 History and Growth of Mutual Fund Industry
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Phase III: Emergence of private sector funds (1993 – 1996)
The permission was given to the private sector funds including foreign
funds management companies (most of them entering through joint
venture with Indian promoter) to enter the Mutual Fund industry in
1993. With the entry of private sector funds in 1993, a new era started in
Indian Mutual Fund industry, giving the Indian investors a wider choice
of fund and therefore giving rise to more competition in the industry.
Private funds introduced innovative products, investment techniques and
investors servicing technology during 1994. In 1993 the first Mutual
Fund regulation came into being under which all Mutual Funds, except
UTI was to be registered. The Kothari Pioneer (now merged with
Franklin Templeton) was the first private sector Mutual Fund registered
in July 1993. The number of Mutual Fund houses went on increasing
with many foreign Mutual Funds setting up funds in India and also the
industry witnessed several mergers and acquisitions.
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Phase V: Growth and Consolidation (2004 onwards)
The industry witnessed several mergers and acquisition. Recent
players entered India like Fidelity, Franklin Templeton Mutual Fund etc.
of the stock market has contributed to the growth of Mutual Fund. But
the penetration of Mutual Fund in the retail investors segment is still low
investor will further boost the Mutual Fund industry in India. Today the
Mutual Fund industry must tap the huge untapped potential in the
country.
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1.5 Types of Mutual Fund Schemes
Mutual Fund schemes may be classified on the basis of its structure and
investment objective.
Mutual Fund
By Structure
Interval Scheme
By Investment
Others
Exchange Trade
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1.5.1.2 Closed-ended Funds
A closed-ended fund has a stipulated maturity period which generally
ranges from three to fifteen years. The fund is open for subscription only
during a specified period. Investors can invest in the scheme at the time
of the initial public issue and thereafter they can buy or sell the units of
the scheme on the stock exchanges where they are listed. In order to
provide an exit route to the investors, some close-ended funds give an
option of selling back the units to the Mutual Fund through periodic
repurchase at NAV related prices.
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1.5.2.3 Balanced Funds
The aim of balanced funds is to provide both growth and regular
income. Such schemes periodically distribute a part of their earning and
invest both in equities and fixed income securities in the proportion
indicated in their offer documents. In a rising stock market, the NAV of
these schemes may not normally keep pace, or fall equally when the
market falls. These are ideal for investors looking for a combination of
income and moderate growth.
1.5.3 Others :
1.5.3.1 Tax Saving
These schemes offer tax rebates to the investors under specific
provisions of the Indian Income Tax laws as the Government offers tax
incentives for investment in specified avenues. Investments made in
Equity Linked Savings Schemes (ELSS) and Pension Schemes are
allowed as deduction u/s 88 of the Income Tax Act, 1961. The Act also
provides opportunities to investors to save capital gains u/s 54EA and
54EB by investing in Mutual Funds.
1.5.3.4 Sectoral
Sectoral Funds are those, which invest exclusively in a specified
industry or a group of industries or various segments such as 'A' Group
shares or initial public offerings.
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1.6.2 Diversification
Mutual Funds invest in a number of companies across a broad cross-
section of industries and sectors. This diversification reduces the risk
because seldom do all stocks decline at the same time and in the same
proportion. This diversification is achieved through a Mutual Fund.
1.6.6 Liquidity
In open-end schemes, an investor can get his money back promptly at
net asset value. With closed-ended schemes, an investor can sell his
units on a stock exchange at the prevailing market price or avail of the
facility of direct repurchase at NAV related prices which some close-
ended and interval schemes offer periodically.
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1.6.7 Transparency
Regular information can be obtained by the investors on the value of
investment in addition to disclosure on the specific investments made in
the scheme, the proportion invested in each class of assets and the fund
manager's investment strategy and outlook.
1.6.8 Flexibility
Through features such as regular investment plans, regular withdrawal
plans and dividend reinvestment plans, an investor can systematically
invest or withdraw funds according to his needs and convenience.
1.6.11 Affordability
Mutual funds allow even small investors to indirectly reap the benefit of
investment in shares of a big company because of its large corpus, which
an individual investor may not be able to do so because of insufficient
funds.
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1.7 Limitations of Mutual Funds
Following are some of the limitations of mutual funds.
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shareholder fees, in the forms of loads and redemption fees are paid
directly by shareholders purchasing or selling the funds. The annual
fund operating fees are charged as an annual percentage – usually
ranging from 1-3%. These fees are assessed to mutual fund investors
regardless of the performance of the fund. Mutual funds are subjected to
market risks or assets risks. If the investment is not sufficiently
diversified, it may involve huge losses.
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